Warren Buffett warns investors on the perils of cash

Albert Einstein once said: "If you can't explain it to a six-year-old, you don't understand it yourself."

The ability to simplify complicated concepts is a common trait among geniuses. Whether in science, architecture, engineering or investing, the smartest people are able to provide clarity to complexity.

Often it is not the idea itself that is the stroke of genius. We will read or hear something explained and exclaim, 'Well, I could have thought of that'. We could have. But we didn't. Because it is the ability to pull that one idea out of the thousands of alternatives and say this is the one thing you need to be thinking about that makes someone truly insightful.

Warren Buffett says share prices will always be far more volatile than cash-equivalent holdings, but over the long term currency-denominated instruments are riskier investments. Photo: Bloomberg

And that's why Warren Buffett's annual letters to shareholders are so eagerly anticipated.

None of us expect a great stock tip or a specific idea that is going to make us a fortune. What we get, every year without fail, is a distillation of a very complicated world into one or two key principles that invariably end up being more important than all of the noise.

Advertisement

This year's letter was no exception. And the lesson was on the perils of holding cash. Comparing the 11,196 per cent return from holding the S&P500 over the past 50 years with an 87 per cent depreciation in the value of a dollar of cash during the same period, Buffett reached an inescapable conclusion:

"Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions."

Incongruous

The comparison of the sharemarket with cash is a slightly incongruous one. You would have made a lot of money invested in equities but each dollar still buys you 87 per cent less than it did 50 years ago. And, presumably, you would have made a decent amount of interest had you just held cash in the bank.

But the point stands. By investing in cash you are certain to lose buying power over a long period of time.

It is a timely piece of advice and intentionally so. Not a day passes without someone opining on the perils of central bank influence on asset prices and the coming crash when the punchbowl is removed. We're worried about deflation – the world is turning Japanese. We're worried about inflation – how can all of this money printing not result in rampant inflation? The developed world has an ageing population – how can we possibly support all those retirees? We're worried about rising interest rates, falling interest rates and China's economy collapsing.

Don't get me wrong. These are all justified concerns and issues the world is going to have to deal with. I have no doubt Buffett is thinking about them and knows a lot more than you or I. But, as usual, it's his ability to see the forest for the trees that sets him apart.

Advertisement

These risks we spend our lives fretting about pale in comparison to the risks associated with holding large amounts of cash for long periods of time.

"[The long-term investor's] focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities."

It is Warren Buffett's ability to see the forest for the trees that sets him apart. AFP

While reading about Grexits, quantitative easing and ghost cities in China, we must keep this fundamental tenant front and centre of our thinking. Long-term savings should be tied up in real investments that protect, and hopefully increase, our purchasing power over time.